ALL BUSINESS: Financial reform for the masses

Monday

Jul 26, 2010 at 7:28 AM

RACHEL BECK

NEW YORK - The battle over financial regulation is finally over. Now comes the harder part: kicking Americans' love of credit.

The financial crisis didn't happen just because banks, credit-card companies and mortgage lenders forced consumers to take on massive debt. We willingly gobbled up the easy credit they offered and used it to buy cars and houses, take vacations and go shopping.

Then came the blowup. All that debt, matched with one in 10 Americans unemployed and plunging home prices, strangled our finances and ultimately, the overall economy.

New regulations, which President Barack Obama signed into law on Wednesday, can only go so far to prevent future financial crises like the one we are living through. Banks will still lend. And many of us will borrow too much.

"You can't legislate diligence," says Robert Lawless, an expert on consumer credit at the University of Illinois College of Law and a contributor to the blog Credit Slips. "You can't pass laws that make people be careful when they take out loans."

There are already signs that lenders are eager to lure us back. Credit-card solicitations jumped 45 percent during the first half of this year to 884 million, according to estimates from research firm Synovate.

And all that talk about limiting lending to consumers with risky credit profiles seems to be fading. Issuers mailed nearly 85 million credit-card offers to subprime borrowers during the first six months of 2010, double year-ago levels, Synovate estimates.

That kind of growth has to do with one thing: The card issuers know they can make more money off of riskier borrowers because they can charge higher interest rates and annual fees, says Synovate's Anuj Shahani.

More evidence of credit expansion came Thursday when General Motors said it would buy subprime lender AmeriCredit Corp. for $3.5 billion in a deal that will let the automaker increase lending to customers with poor credit.

Let's be clear: not all borrowing is bad. Taking out a loan to buy a car is the kind of purchase that requires us to borrow. Having access to credit also keeps the economy going, since we can't pay for everything with cash.

However, we still need to be careful. Amazingly, the pace of consumer borrowing hasn't fallen off that much, even in the wake of the recession and financial crisis. Mortgage lending has dropped, but borrowing on credit cards and other loans, such as for autos, is only slightly below historical levels.

Federal Reserve data shows consumer borrowing ran at an annual rate of $2.42 trillion in May. That was the 15th decline in 16 months, but the amount is still on par with the winter of 2007, when credit was still booming.

The new rules might get rid of the riskiest loans in the marketplace. Regulators will be able to ban financial products they think are unsafe or outlaw things that might be confusing, like the fine print on credit card or mortgage applications. Mortgage lenders will also be required to verify a borrower's income, credit history and employment status.

Those are good first steps, but they'll be meaningless if Americans continue to ignore the basics rules of avoiding credit disasters.

We have to understand the kinds of loans were are getting, and whether we can afford them. An adjustable-rate mortgage isn't a bad thing on its own, but it can be if you don't realize your rate could go from 2 percent to 10 percent five years from now.

We don't need a wallet full of credit cards. We have to save more. We have to read the disclosures on every loan we get.

"You can't force people into long-term financial stability," says Todd Mark, vice president of education at the Consumer Credit Counseling Service of Greater Dallas. "Plenty of people still don't understand the dangers of debt."

Mark and other credit counselors worry what happens next, when the economy improves and credit flows more freely. If the unemployment rate finally retreats, the bingeing could come back, maybe even more than before.

"When credit is easy, it can be rational to over-borrow," says Lawless of the University of Illinois.

Unless Americans radically change their approach to credit, we know where this story goes in five or 10 years. It will look a lot like the mess we're in today.